Record bank debt coming due

Aug. 26 (Bloomberg) -- Merrill Lynch & Co.,
Wachovia Corp., Lehman Brothers Holdings Inc. and the rest of the U.S.
finance industry are about to find out how expensive credit has become.

Banks, securities firms and lenders have a record $871 billion of bonds maturing through 2009,
according to JPMorgan Chase & Co., just as yields are at their most
punitive compared with Treasuries. The increase in yields may cost them
as much as $23 billion more in annual interest versus a year ago based
on Merrill Lynch index data. Higher refinancing expenses will restrict
the ability of banks to borrow in the capital markets and lend, further
cutting off credit to consumers and businesses and curbing what is
already the slowest growing economy since 2001.

"The gears of capitalism are grinding to a halt,'' said
Mirko Mikelic, senior bond fund manager at Grand Rapids, Michigan-based
Fifth Third Asset Management, which oversees $21 billion in assets.
"There is a tremendous concern over the banking sector and a scramble
right now for capital.''

And here’s
the data I’ve been waiting for. To the exhaustive pile of new borrowing
that the US government needs to shoulder, we can add $871 billion of
debt that financial firms will need to somehow fund at the exact same
time. I will be more than a little surprised if this does not result in
either drastically higher interest rates, or massive inflation.

In the higher rate scenario, the Federal Reserve shows some restraint
and does not try to solve the problem with printing, meaning that all
this borrowing has to compete for limited investment funds. When firms
compete for money, they do it by offering higher and higher rates to
attract that capital to themselves. So interest rates will rise. In the
other scenario, the Fed simply expands its alphabet-soup lending
facility programs and hands out dough for debt.

This is also
known as “monetizing debt,” and is one of the key events that I am on
vigilant alert for, since it will presage the beginning of massive
inflation, the destruction of the dollar, or both. As always, I
consider the monetization of debt to be twice as likely an outcome as
the prospect of spiraling interest rates.